Scottish independence: Why a Scottish pound from day one is the best course

The currency part of Monday’s economic proposals for independence represents significant change, despite the surface similarity to the Scottish Growth Commission (SGC) in 2018.

The change is in the planned timing of the transition from sterling to a Scottish pound. The SGC suggested that use of sterling could continue for a “possibly extended transition period” of very uncertain length. The new proposals instead envisage a Scottish pound being introduced “as soon as practicable”.

In her press conference, Nicola Sturgeon refused to be drawn on precise timing, but she pushed back on a questioner suggesting “a decade or more”. The message on a new currency is now ‘when, not if’. The tests outlined will be passed, even if we cannot yet know the precise timing.

Informal currency union with the remaining UK (rUK) is now something to be exited as soon as possible. The chaos in Westminster and the gilt market may further increase the attractions of independence, but it also emphasises the potential difficulties of retaining sterling for any period after independence.

First Minister Nicola Sturgeon speaks at a press conference at Bute House in Edinburgh to launch a second independence paper. Picture: PA Images

Informal currency union is less attractive than the formal union proposed in 2014. Scottish businesses and households, in additional to the Scottish Government’s borrowing capacity, would still be subject to the UK Government bond market reaction to UK policy, but with the Bank of England having no responsibility to mitigate the impact in Scotland.

The six requirements and criteria for transition to a Scottish pound show the Scottish Government’s thinking. There is not , however, a convincing case for using sterling after independence rather than seeking to launch the new currency at independence.

Some of the tests must be met at independence, rather than waiting for them to be fulfilled before transition to a Scottish pound. Before a new currency Scotland would, the proposals say, need the institutional structure – the key fiscal, financial and monetary institutions, such as a central bank, debt management office and an enhanced Fiscal Commission, with expertise and credibility.

However, Scotland cannot be successful in the initial years of independence unless these institutions have expertise and credibility at independence. This is also true of market confidence and credibility in the macroeconomic framework to support a transition to a new currency.

This transition is as soon as practicable, so investors at independence need confidence in the transition plan to invest long-term in Scotland. Otherwise, investment will be at best short term.

Investors will ideally also want a clear timetable. A third criteria is that Scotland is fiscally sustainable. Will Scotland be perceived as fiscally unsustainable at independence? The answer must be no for independence to be successful, and sustainability will have to include the situation after transition.

Some tests are largely irrelevant. For example, a requirement is that change is in the economic interests of Scotland, and meets the macroeconomic objectives of improved competitiveness and enhanced economic resilience. The Scottish Government has presumably already decided this.

This is therefore little more than ‘we reserve the right to change our minds’, with the costs of increasing uncertainty without meaningful gain.

Last, a criteria is that foreign exchange reserves and sterling reserves are sufficient. Sterling reserves would be relevant only during the time that Scotland is using sterling, and then are foreign currency reserves.

Foreign exchanges reserves are unlikely to be a meaningful constraint unless Scotland intends to intervene to support the new currency’s value.

A floating currency requires relatively low levels of reserves. If Scotland attempts to fix its currency to another such as sterling, much higher levels of reserves are needed, as the UK found to its cost in 1992. Without a strongly positive current account balance, building that level of reserves in any reasonable timescale seems unlikely.

Two further tests point to the core of any debate. Both that the institutional structure can be extended to take on additional functions to support the introduction of a Scottish pound and time for new institutions to be created suggest a concern that there is insufficient time between a favourable referendum result and actual independence to set up the capability to manage the new currency.

The institutional challenges needed for independence are large, but the experience of other countries shows they are not insuperable. The proposals place high value on more time for the additional institutional challenges of a new currency. This seems to me questionable.

Lastly, the proposal wants time for these institutions to establish a track record of responsible economic management, especially the central bank.

A track record is helpful to the credibility of all institutions and governments, but its importance here should not be over-stated.

The report lists five ways fiscal credibility could be established, of which a track record is only one. That record can only be in a very limited role without setting monetary policy, with a risk of a track record of not being able to do very much.

The credibility the central bank will need on independence will be based on factors such as the identity and prior track record of the individuals appointed, especially of the new Governor. Market perception of a new Governor’s credibility as sufficient in the context of using sterling would differ little from the credibility to manage that new currency. An institutional track record is only a small benefit.

The proposals set the minor positives of more time to establish administrative capacity and a track record against the clear negative of that time involving continued use of sterling outside a formal currency union, a choice made by none of the ‘successful independent countries’ the proposals discuss.

Recent events highlight the potential minimum costs of such an arrangement. The proposal is "grounded in practicality for households and businesses”, but the currency proposal is neither practical nor necessary. We should adopt a Scottish pound on independence.

- After 15 years working in the bond markets, Dr Iain Hardie has lectured in political economy and researched financial markets at the University of Edinburgh since 2007.